The Coming Bank Credit Crunch

Banks in the US are going to need to roll over almost $800 billion dollars in medium-term debt in the next 16 months. Banks borrowed heavily in 2006, a lot of it in 2-3 year floating-rate notes, and now they must refinance those notes.

Say a bank borrowed at LIBOR plus 50bps. In today’s environment, many banks are not going to be able to borrow at such low rates.

Remember the 2 Ohio banks mentioned earlier? These regional banks will have to pay spreads of 7-9%, based on the price of their debt today. If you have to pay 12% to borrow money when prime is at 5% and you're lending at 6-8%, you clearly cannot make a profit. That means they will have to sell assets or raise very expensive equity capital.

There are a lot of small and regional banks that are in trouble. The FDIC has a list of 117. Out of (I think) 8500 banks, that doesn't sound bad. But remember: IndyMac, which failed a few months ago, was not on that list. Banks can get into trouble rather quickly if they cannot raise capital, sell assets, or borrow money due to perceived distress.

The problem is that these banks will have less money to lend and will be calling loans from otherwise good customers, which of course makes the economic situation even worse. It is a vicious cycle.

Even many mainstream economists are now suggesting we will be in a recession by the 4th quarter, if we are not in one now. (The 2nd quarter revised GDP was 3.3%. This is an anomaly, and is highly unlikely to be repeated.) The recovery, when it comes, will be tepid until credit spreads signal an end to the credit crisis. It is going to be Muddle Through for 2009. This is NOT going to be good for the stock market. When will it be safe to get back into the water? Pay attention to credit spreads.

One other thing to watch. When the Fed feels it's no longer necessary to offer “temporary” Term Auction Facilities (loans) to commercial and investment banks, that will be a significant event.

Notice that these were to be temporary. These auctions will last well into 2009 and maybe longer.